Asymmetric Information, Debt Capacity, and Capital Structure

Posted: 20 Mar 2012Last Revised: 22 Aug 2016

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Date Written: June 2, 2016

Abstract

We present a tradeoff theory of capital structure in which costs associated with asymmetric information are the sole friction. By considering both the amount of debt as well as the restrictiveness of the associated debt covenants a more complete characterization of debt structure is examined than is considered in the standard tax/bankruptcy cost tradeoff model. The leverage choice, the restrictiveness of the associated debt covenants, and the renegotiation of the covenants are examined and empirical implications are developed.